Encompass Health Corp Q3 FY2022 Earnings Call

Good morning, everyone, and welcome to Encompass Health's Third Quarter 2022 Earnings Conference Call. Today's conference is being recorded. I will now turn the call over to Mark Miller, Encompass Health's Chief Investor Relations Officer. Please go ahead, sir.

Thank you, operator, and good morning, everyone. Thank you for joining Encompass Health's Third Quarter 2022 Earnings Call. Before we begin, if you do not already have a copy, the third quarter earnings release, supplemental information and related Form 8-K filed with the SEC are available on our website at encompasshealth.com. On Page 2 of the supplemental information, you will find the safe harbor statements, which are also set forth in greater detail on the last page of the earnings release. During the call, we will make forward-looking statements, which are subject to risks and uncertainties, many of which are beyond our control. Certain risks and uncertainties like those relating to regulatory developments as well as volume, bad debt and labor cost trends that could cause actual results to differ materially from our projections, estimates and expectations are discussed in the company's SEC filings, including the company's earnings release and related Form 8-K, the Form 10-K for year ended December 31, 2021, and the Form 10-Q for quarters ended March 31, 2022, June 30, 2022, and September 30, 2022, when filed. We encourage you to read them. You are cautioned not to place undue reliance on the estimates, projections, guidance and other forward-looking information presented, which are based on current estimates of future events and speak only as of today. We do not undertake a duty to update these forward-looking statements. Our supplemental information and discussion on this call will include certain non-GAAP financial measures. For such measures, reconciliations to the most directly comparable GAAP measure is available at the end of the supplemental information, at the end of the earnings release and as part of the Form 8-K filed yesterday with the SEC, all of which are available on our website.

Mark, thank you, and good morning, everyone. We continue to see strong underlying demand for our services in Q3, with total discharge growth of 7.5%, including a 4.1% increase in same-store discharges. Our value proposition is resonating across payers, and we are gaining share in what remains an underserved market. Our hiring and retention strategies again proved effective at reducing our reliance on agency staffing, leading to another quarterly sequential decline in contract labor FTEs and expense in Q3. Market conditions for skilled clinicians remain challenging and the benefits of lower contract labor in the quarter were partially offset by higher sign-on and shift bonuses. Our Q3 profitability was negatively impacted by hurricane activity, delayed openings at 2 de novos and inflationary effects on supplies and utility costs. These factors led us to revise our 2022 guidance, as Doug will address in greater detail in just a few minutes. These are not the results we'd hoped for, but we are extremely proud of how our team has continued to respond to this volatile and challenging environment. Our de novo embedded edition strategies are increasing the availability of the highly specialized services we provide to meet this rising demand. Our commitment of substantial capital to these capacity expansions underscores our confidence in the future prospects of our IRF business. We opened 3 de novos in Q3, making that 9 year-to-date. We expect to open 8 de novos in 2023. We added 20 beds to existing hospitals in the quarter, raising the year-to-date total to 87. We expect to add an additional 100 to 125 beds in 2023. In the design and construction of our de novos, we are furthering our utilization of prefabrication to enhance speed to market, ensure consistent quality and contain costs. We are working on a number of new initiatives for the next generation of prefabrication and look forward to sharing more details with you in early 2023. As we have discussed previously, we have responded to the challenging labor market for skilled clinical resources in a number of ways, including adding substantial resources to our talent acquisition team. Our strategy of building a centralized recruiting function is generating successes. Same-store net RN hires were 459 for the first 3 quarters of 2022 as compared to 289 in the same period last year, a 62% increase. Q3 same-store net RN hires of 183 is up from 149 in Q2 and 127 in Q1. We also remain keenly focused on managing productivity. Our EPOB for Q3 was 3.39%, in line with our expectations. We achieved this productivity even while opening 3 de novos in the quarter. We are also continuing to create favorable outcomes for our patients and thereby our payers. Our Q3 discharge to community rate was 81.9% as compared to 81.3% in the year-ago period, and our discharge to SNF rate was 7% as compared to 7.5% in the year-ago period. Moreover, our staffing challenges have not hindered our ability to provide great patient care as evidenced by our favorable Net Promoter scoring trends for patient satisfaction. On October 1, the fiscal year 2023 IRF rule became effective providing us with an approximately 4% Medicare price increase. This is the largest price increase we've had in quite some time. The market basket update leading to this increase is based on trailing information and lags the prevailing inflationary environment. We are optimistic that ensuing reimbursement changes will close that gap. The benefit of this Q4 reimbursement increase is being partially offset by sequestration. On the regulatory front, the improving Medicare Post-Acute Transformation Act of 2014, known as the IMPACT Act requires collection and reporting of quality measures in standardized patient assessment data elements across post-acute providers. The 2022 IRF-PAI 4.0 form is now 30 pages of admission and discharge interdisciplinary data elements. Consistent with our prior regulatory update, we began preparations for these changes well in advance to ensure that our associates were well trained and fully ready for transition. We have implemented IRF-PAI 4.0 across all of our hospitals with little to no disruption to our operations. While CMS has not yet announced a start date for IRF review choice demonstration, it is slated to begin in Alabama first. We have been proactively communicating with our Medicare administrative contractor for Alabama regarding the potential implementation process. With regard to our revised 2022 guidance, we now expect net operating revenues of $4.32 billion to $4.35 billion, adjusted EBITDA of $800 million to $820 million and adjusted EPS of $2.71 to $2.86 per share. The key considerations underlying this guidance can be found on Page 13 of the supplemental slides.

Thanks, Mark, and good morning, everyone. I'll start with a quick recap of Q3. Q3 revenue increased 7.8% over the prior year to $1.09 billion and adjusted EBITDA declined 2% to $195.3 million. Our year-to-date adjusted free cash flow was $294 million. As Mark discussed, we continue to see strong volume growth that combined with a modest 0.7% increase in revenue per discharge produced 8.2% inpatient revenue growth in the quarter. Once again, staffing challenges did not limit volume growth, but did result in the continuation of elevated costs. Our Q3 contract labor plus sign-on and shift bonuses of $49 million were comprised of $24.8 million in contract labor and $24.2 million in sign-on and shift bonuses. Contract labor expense in Q3 declined approximately $10.3 million or 29% from Q2 and $17.1 million or 41% from the Q1 peak. We experienced sequential declines in contract labor expenses and FTEs for every month in Q3, and in fact, for every month since March of 2022. Contract labor FTEs peaked at 749 in March, declined to 597 in June, and fell further to 447 in September. Agency rates also declined during the quarter. The Q3 agency rate per FTE was $205,000 as compared to $223,000 in Q2. Agency rates do remain market specific and highly variable. As an example, after steady monthly declines, we experienced an uptick in average agency rates in September. Consequently, while we expect our total contract labor costs to decline again in Q4, our revised guidance assumes the pace of improvement will be slower than previously expected. Sign-on and shift bonuses increased sequentially to $24.2 million from $21.8 million in Q2. Sign-on bonuses increased approximately $1.8 million, and shift bonuses increased approximately $600,000. We had expected less of an increase in sign-on bonuses and we also expected a decline in shift bonuses as we moved from Q2 to Q3. The increases stem from the net new RN hires, higher sign-on bonuses at the 3 de novos opened during the quarter and the use of shift bonuses to cover periods of unexpectedly high clinical staff PTO usage during the summer. Our updated guidance assumes sign-on and shift bonuses will decline in Q4, albeit at a slower pace than previously expected. As Mark noted, we remain very pleased with the results of our de novo and bed addition programs. We had previously expected our 2022 de novos to be breakeven to modestly accretive in the second half of the year. However, during Q3, opening delays at 2 of our hospitals, higher initial staff recruiting costs, and hurricane-related disruptions at our newly opened Naples facility led to approximately $5 million in net preopening and ramp-up costs incurred in the quarter. Our updated guidance assumes that 2022 de novos will be approximately breakeven in Q4. There are 3 other items that arose in Q3 that were outside of our expectations, negatively impacting our adjusted EBITDA for the quarter and contributing to our revised guidance. Net provider tax revenues, which can be volatile from quarter to quarter and thus are difficult to forecast, declined by approximately $2 million as compared to Q3 of last year. Utility costs exceeded our expectations based both on higher utilization and increased rates. The higher utilization occurred primarily in Texas and Florida, our 2 largest markets, which both experienced very hot summers. Utilities expense per patient day increased by approximately 13% over Q3 last year and 21% over Q2. And finally, food costs increased beyond our expectations as inflationary pressures drove the cost per patient day up 15% over the prior year period and accelerating from up almost 8% in Q2. An enumeration of key assumptions underlying our revised guidance may be found on Page 13 of the supplemental slides. And with that, we'll open the line for questions.

With that, I'll turn the call back over to Mr. Mark Tarr.

So I guess I wanted to focus on labor. Obviously, you took up the labor outlook for Q4. I mean how are you thinking about the improvement into next year? How should we think about wages? How should we think about contract labor? And then I think sometimes people think that there may be too much of a lift to the bottom line for contract labor going down because you have to fill that with a full-time person. How should we think about kind of wage growth next year, but then the net-net of contract coming down? And is this normalized next year? Or is this a 2- or 3-year kind of thing that we should be thinking about for labor?

So Kevin, it's Doug. I don't know that we'll fully return to normal because it's unclear what that means in 2023, but we do expect to see an improvement from Q3 to Q4. Overall, for 2023, we anticipate better results compared to 2022 in both contract labor and sign-on and shift bonuses. There is still a lot of volatility. As I mentioned earlier, we noticed an increase in the average rate in September after experiencing declines from March onwards. Projecting total contract labor expense is challenging, but we currently estimate it to be between 250 to 300. This figure might actually range from 300 to 350, and the lower end of that range looks optimistic. Additionally, there are a couple of factors that introduce uncertainty, making it hard to give you a straightforward answer. In the fourth quarter, we have a significant amount of PTO around the holidays, and we're unsure of how that will affect staffing, similar to what we saw in the summer with associates taking time off. Lastly, while it seems unlikely that the coronavirus will pose severe challenges this winter as initially feared, there are still concerns about a potential winter surge of COVID alongside a more volatile flu season. Both scenarios could lead to staffing issues during what is typically our peak volume period of the year.

Kevin, this is Mark. I just want to add in there. We mentioned earlier about adding the talent acquisition resources. I mean we've done a number of things to make sure that we're well positioned going forward to do everything that we can to support our hospitals and fill the open positions that we have. And we now have over 60 full-time recruiters that have centralized that recruitment function that takes some of the load off of the local hospitals in order to do that. And as evidenced by our net RN hires, we're making some significant progress on that. So we are doing everything we can to strategically position us against this very challenging environment.

So, the last thing I'd throw in there, I'm probably piling on, but it doesn't relate to specific contract labor, but rather to the sign-on bonuses. And we have made some significant progress in kind of getting some standardization around those. And also, we've been successful at now paying less of the amount upfront and tying more of it to retention periods. And those vary a little bit from market to market based on the competition. But whereas earlier in this year, we were having to pay a significant, if not all, of the sign-on bonus upfront and take risk around retention, we're now able to tie that. Now that creates a bit of confusion on those payments, for instance, a substantial portion of what you'll probably see in Q4, as our reported sign-on bonuses actually relate to the hires that were made in Q3. But overall, that's a positive trend.

I think it's safe to say we're testing, we're challenging the marketplaces in terms of the overall amount. And if the sign-on bonus is even required as well as the level of shift bonuses and the rate we're willing to pay on contract labor.

And I think we've just had a record for the longest answer to a single question.

I'm still looking for the wage growth number, but could you share the expectation for next year? Also, regarding your comment that labor is improving more slowly than anticipated, which we've heard from others in recent quarters, is there a specific reason for that? Should we expect a faster improvement next year, or should we prepare for a slower improvement over a longer period?

First of all, in response to your question about 2023, I want to provide some insight into the underlying wage growth after accounting for certain factors. When we examine our salary and wage benefit increases, excluding sign-on and shift bonuses as well as contract labor, we see that in the second and third quarters, it was around 3.5% compared to 4.7% year-over-year. This indicates that we are not observing any significant concerns regarding core wage inflation, and I anticipate a similar or possibly lower figure, around 3%, for Q4. Regarding contract labor usage, one unexpected factor we noticed was that our clinical staff had accumulated a considerable amount of paid time off due to the increased demand for additional shifts, especially during the early pandemic when they had limited time away. They began to take this time off during the summer. Given our strong facility volume, we adopted the approach of managing labor needs later, which resulted in us utilizing more contract labor in the third quarter than we originally expected.

We'll take our next question from Andrew Mok with UBS.

Just wanted to ask a little bit about the framework for 2023. The midpoint of the revised guidance range implies about $223 million of EBITDA in Q4, which annualizes to about $392 million before considering any growth for next year. Are there any items that you would call out that impact that 4Q run rate? And if not, is that a reasonable way to think about 2023?

I understand that everyone is eager to hear more about 2023, but you will likely find some more troubling insights in reports from other providers across various industries. There remains significant volatility and uncertainty, making it challenging to forecast business trends beyond the near term. However, we are quite optimistic, as Mark mentioned, about the strong underlying demand for our business, which is reflected in our volume growth for Q4. That said, it's difficult to predict how representative Q4 will be of our experience in Q3, especially with the political landscape shifting following the midterm elections and various geopolitical risks at play. We do anticipate continued positive volume growth in 2023 and expect good contributions from the new locations we opened in 2022 as they continue to ramp up. Additionally, we expect improvements in labor expenses, though it's hard to specify the exact levels. Unfortunately, we will provide more concrete guidance for 2023 alongside our Q4 earnings report, which is scheduled for January.

Got it. Okay. But there's nothing you would call out as materially impacting the 4Q run rate at this distance?

No. I think anything we can there on the side of too much detail. But if you look at the fourth quarter, it's full year 2022, but there is only one quarter left. If you look at the guidance considerations that we enumerated, I think they're pretty thorough.

Got it. Okay. And then just a follow-up on the volume side, same-store growth was up 4% on a very difficult 3Q '21 comp. Mark, you made some comments in your prepared remarks that you're taking market share. Can you elaborate on what you're seeing and where those share gains are coming from? What are the primary drivers of those gains?

Yes. So I also comment on the quality outcomes in my prepared statements, and I attribute our ability to take market share from other post-acute providers. And if you look back, going back to 2020 with COVID, I mean, I think we really have proven ourselves very capable of taking on a higher acuity patient and doing a great job getting over 80% of them back to the community. So I think our continued commitment to quality, development of programs, specifically around stroke and other neurology continues to put us in a position to be the favorite post-acute provider in the marketplaces that we exist.

And in the quarter on a year-to-date basis, we continue to see discharge growth across all payer categories. If you were to look at our patient mix for the quarter, we're actually down a little bit in stroke and neurological, which are 2 of our larger categories because they are comprised of very medically complex patients. But that is because of what we had anticipated we would see all along, which is patient flows start to normalize, we're not losing volume in stroke and neurological. It's simply not growing to some of the other faster categories, which had been a little bit more absent during the early stages of the pandemic. So there's a lot of good news in both the payer mix and the patient mix underlying the support for that volume growth. Just to throw a couple of things out there as well. We've talked before just about how large and underpenetrated we believe the total addressable market is. And as we've mentioned in this context before, one of the proxies that we look at is CMS-13 eligible discharges coming out of the acute care facilities across the nation. And as a reminder, only 60% of the patients admitted into any particular IRF during the course of its fiscal year have to be CMS-13. Now we run at a higher compliance level than that, something in the low 70s. But even with that, only 13.5% of the CMS-13 eligible discharges in the nation who come out of a hospital wind up in an IRF. And we think we're making strides on a market-by-market basis at increasing that conversion rate. I do want to remind everybody as well that as you think about Q4, and we remain very optimistic about growth. But we're up against another tough comp because Q4 discharge growth last year was up 9.6%, including 6% on a same-store basis.

We'll take our next question from A.J. Rice with Credit Suisse.

Why don't we put A.J. back in the queue and move to the next one, operator.

We'll move to Pito Chickering with Deutsche Bank.

Just to ask Andrew's question in a different way. Historically, 4Q annualized has been a really good predictor about next year's EBITDA. And I understand that forecasting today is nearly impossible but all the volatility in the current macro environment, but assuming the macro doesn't change at all, is there any structurally wrong taking that number and annualizing again, with the caveat that things changed, and that's okay before you guys give formal guidance?

The only thing if you're trying to use Q4 as a proxy for the following year, and I'm not suggesting whether or not that's a good practice because I've already given you the caveat that there is a lot of volatility. You've got to remember to factor in seasonality, which is more pronounced in Q4 and Q1, and you would also need to factor in that you will have another year where we're opening up 8 de novos, and so there will be probably a fairly similar level, maybe at a lower level this year because of some of those factors that I pointed out in Q3 and start-up and ramp-up costs. There's nothing else that comes to mind that I would suggest it was an anomaly. You do have the impact of sequestration when you're looking at a year-over-year basis, but it is fully implemented now beginning with Q3. So it depends on whether you're just trying to look at it sequentially or on a year-over-year basis.

Okay. Perfect. And then looking at building de novos, did the ROIC change at all with these new building costs that they're embedded in these projects and the additional sign-in bonuses that needs to pay in order to ramp this up and then potentially slower Medicare certification due to staffing?

Yes. When you increase preopening and ramp-up costs, you can incorporate those additional losses into the invested capital when calculating your ROIC. However, when you total the capital spent on the new projects this year, the increase beyond expectations was about $5 million, which doesn't significantly impact ROIC. Once we open these facilities, we've observed a quicker ramp-up than anticipated. Like many others nationwide, we’ve experienced a 25% to 30% rise in key design and construction costs, primarily due to materials, although that trend is starting to decrease, which is encouraging. Nevertheless, the combination of rising construction costs and higher labor costs affects the early years of ROIC. This has been mostly balanced by the quicker growth in average daily census we've observed with these facilities. Additionally, the use of prefabrication has helped maintain costs, and while we believe it will lead to savings, it is also speeding up our time to market, positively affecting the return characteristics of the new projects. We remain very optimistic about the returns we are projecting from this capital investment.

One thing we're really appreciating about prefabrication is the speed to market. The construction time for an entire hospital has been reduced from 9 months to 6 months, and for adding beds, it's about half that time. This speed is crucial in competitive markets, and we've specifically noticed it in Florida, which makes us optimistic about the direction of our prefab construction efforts.

And those periods that Mark just mentioned related to construction specifically. There's also a design benefit to it. So the more you move towards prefabrication, the faster we can get the design for a new facility, retrofit into the land that we acquire, the faster it can get through the permitting process as well. So we're taking incremental time out of the project and on the front end as well. And so in aggregate, we feel like we've knocked 30% to 40% over the time to open up a facility. That's not going to be the case everywhere. Sometimes permitting and zoning is more difficult in other markets. But as a generalization, that's the kind of result we're seeing.

Okay. And then just really just a quick numbers question on the OpEx, you talked about the increase in food costs and energy costs? And then if you can quantify this for us in the OpEx line and then what you can impact in 3Q and 4Q?

Versus our previous expectations, each of those categories was up just over $2 million in Q3.

We'll go ahead and take our next question from Pito Chickering with Jefferies.

I'll build on the earlier questions regarding the new facilities. You've added a significant number of beds in 2019, 2020, and 2021, but the pandemic has influenced this situation. Perhaps the growth from these new additions hasn't met your expectations. How are you viewing the potential for a quicker or larger contribution from these new facilities as we look ahead to next year?

Well, it's there in the volume. And the ramp-up on those facilities even opened up during the pandemic has been very positive. And so the flow-through is simply being impacted by the elevated costs that we've talked about. But look at the year-over-year revenue increases, it's evident that the new capacity that's added to those markets is resonating with payers and patients and referral sources. As we continue to make progress, now we've got a pricing increase as well. We probably didn't put enough emphasis on that. In Q3, we faced those increasing cost pressures against essentially a flat price increase. You're hearing about nice earnings gains in certain sectors like consumer brands, McDonald's was out today, yes, they're raising their prices because they've got the flexibility to do that. We had to meet these challenges against flat pricing. Mark alluded to the increase that we're getting in Q4. Again, that's going to be partially offset by sequestration, but it really begins to flow through as we enter 2023. Unless there are changes in the rule-making process just based on the cost of inputs, and you're seeing that across the provider universe right now, we should see another nice price increase in 2023 for the 2024 rule-making process. Then you're really going to see the operating leverage and the efficacy of these de novos and our entire business start to flow through into EBITDA improvement.

Brian, we've brought on now 17 de novos in the last 2 years, and they've all been very successfully ramping up. I think just as an indication of the talent that we have out in the field. Our operators that are largely responsible for bringing these hospitals online, staffing them and getting them up to speed. I just want to do a call out to our teams and the regional presidents that are out there and the depth of talent that we have within this company.

The more you engage in any activity, the more skilled you become at it. We have seen improvement in all aspects of our development process. Our development team is becoming more proficient at identifying promising markets and incorporating an IRF, where we feel a joint venture would be advantageous. Negotiations have become more efficient, and every part of opening and ramping up the facility has improved. However, we did experience some delays in the third quarter, but these were entirely out of our control. For instance, one facility faced a delay in obtaining a critical air handling unit due to supply chain issues, but we believe those issues will be resolved. Overall, we are very satisfied with the outcomes from our de novos.

Next question comes from Ben Hendrix with RBC Capital Markets.

Given the headwinds that you've seen in the past related to claim denial activity. Can you remind us what's involved of the Medicare intermediary TPE? And are there any proactive measures you can take from an operational or documentation perspective to at least partially mitigate future increases and denials?

Yes, we are definitely observing an increase in denials, as indicated in the supplemental slide regarding the resumption of TPE. The most effective step we took to address the traditional ADR issues was implementing our clinical information system, which effectively captures documentation, and we continue to seek improvements. The primary challenge we face with the resumption of TPE is the varying interpretations of Medicare guidelines regarding patient care requirements by intermediaries. For instance, CMS guidelines state that the majority of therapy should be administered in a nongroup or nonindividual setting. While the average person might interpret "majority" literally, some TPEs in certain markets have assessed claims where patients received over 80% of their therapy on an individual basis and still denied them for not meeting the majority requirement. We are increasingly having to manage these denials, which are not yet at a critical level through the appeal processes, and it is quite frustrating. We are delivering high-quality care to our patients and achieving excellent outcomes, which is reflected in our record-high patient satisfaction scores. Yet, we are facing arbitrary decisions on the claims we submit that are made by uninformed parties.

So Ben, we're educating the auditors on the requirements for IRFs as set by CMS rather than them educating us.

Do you see any additional risk with the issues being worsened by the involvement of an increased number of agency nurses or those unfamiliar with our systems or coming from other settings? Does this create any extra challenges for documentation?

Well, it certainly adds the complexity with who will do that. We're careful to make sure that we educate the agency nurses on the use of our electronic medical record system. That's part of the basic orientation even for an agency nurse. So we do everything we can to prevent that from happening, but that is certainly a risk for organizations that don't take the time on the upfront period with the contract staff.

I would also say the key nature of how we approach care in our hospitals means that a contract labor FTE is surrounded by more permanent employees, which helps with that. Also just because our skilled labor force is comprised of nurses and therapists, there's a hierarchy in every hospital to our nursing structure. So their supervision of everybody who's in the facility, not just contract labor nurses.

We next move to Matt Larew with William Blair.

I wanted to ask about the trend in salaries and benefits. In the first half, salaries and benefits per FTE increased by about 8%, and for the second half, it's projected to be around 3%. You've explained various factors contributing to this sequential improvement. Can we assume that the second half of the year trend is more indicative of the future environment? Additionally, agency labor costs have decreased for three consecutive quarters, but are still 30% higher than in 2020, which I assume was already significantly higher than pre-COVID levels. Do you expect this trend to continue downward as well?

It is, Matt. I would just say that there is some uncertainty regarding Q1 for some of the factors I identified earlier, which is that's normally our heavy volume year. It's also the quarter which historically has been most impacted by a flu season. With over the last several years and forget how many years we've been in COVID now, 2 or 3, it's been impacted by a winter surge in COVID. Those could play a role in Q1, but we do expect significant further improvement in overall labor cost through 2023. As we sit here today, the fourth quarter is going to be very important for all of us with regard to that.

Okay. Got it. And then you alluded to the shifts on stroke and neuro just as some other patient normalization. But maybe just give us an overall update on how patient acuity trended through the quarter? You mentioned, I think, last quarter, the quarter before, you're seeing some ortho patients come back. But obviously, you have a 4% price increase started 10 1, but from a patient acuity standpoint, maybe how do you expect that to evolve in Q4 and beyond?

Overall, our acuity was consistent and what has been sequentially in the previous quarters. We may have some shifting among the diagnostic categories. But overall, our acuity was relatively flat.

Yes, across all payers, it was almost exactly flat. I commented that there wasn't a big move, but our Q3 pricing across all payers actually came out slightly lower than we had anticipated. The culprit was less around the patient mix and more around the payer mix. I mentioned earlier that we saw discharge growth across all payers in the quarter. Even though it's a small piece of our business, the most rapid growth that we had in the quarter was in Medicaid. While we've been able to close the gap on Medicare Advantage to less than 5% of the discount to fee-for-service, Medicaid on average remains at about a 35% discount. So that was just another factor. I don't necessarily believe that that's going to continue at that level and typically not enough to call out as we move into Q4 and beyond. But the acuity is staying up there nicely.

Next question goes to Sarah James with Barclays.

I'm trying to piece together the comments you guys made earlier with the 25% to 35% rise in construction costs for key components versus the savings on the prefab. I'm wondering if the net of those 2 changes your preference on de novo versus in-facility bed expansion? And does the increased use of the prefab change your strategy at all for building excess footage into your new facilities?

Yes, those are good questions. One area of focus is bed expansions that are justified by the current occupancy rates in existing facilities. When there are no limitations related to certificates of need or the physical structure of the building, these expansions are always a top priority for our capital expenditures. As we've mentioned, this approach builds on established demand, referral sources, and payer contracts, and we have already engaged in marketing within the market. This creates familiarity, allowing us to leverage essential components of our infrastructure, resulting in high returns. Your second question was very insightful and you are correct. In the past, specifically 3 or 4 years ago, we often entered markets with 40-bed, all private room facilities. Now, we are moving towards 50 or 60 beds due to the rapid increase we’ve observed in the ramp-up of our new facilities and our improving operational efficiency. Additionally, as you pointed out, this strategy helps reduce the average cost per bed. However, I should mention that projecting forward, as we shift from a 40-bed model to a 50 or 60-bed model, this may lead to some fluctuations in future bed expansions. Many of our recent expansion numbers were influenced by the rapid growth of de novo facilities requiring expansions within 2 to 3 years. For instance, North Campo is a recent example where this has happened quite quickly.

Great. And just to follow up on that, the lower cost per bed that you're able to achieve, is there any way that you can frame that savings upfront?

Currently, we are able to maintain our pricing without further increases. We believe that by implementing strategies related to faster market entry and enhanced fabrication, which Mark mentioned in his comments and we will discuss further in Q1, we will be able to reverse the current trend. This approach will be supported by improvements we are already observing in the supply chain, as well as a hopeful reduction in construction labor costs.

And ladies and gentlemen, that does conclude today's presentation. I will turn the conference back over to Mr. Mark Miller for any closing remarks.

Thank you, operator. If anyone has additional questions, please call me at (205) 970-5860. Thank you again for joining today's call.

Ladies and gentlemen, that concludes today's program. You may disconnect at any time.